Dangers of trading frequently and how it can dramatically hurt your returns

Investing is all about patience, so the more you keep buying or selling the less you stand to make. here is a look into the dangers of trading frequently and how it can impact your portfolio, profits and peace of mind
Dangers of Frequent Trading

To me, nothing is more compelling than seeing some cold, hard numbers as a motivation to change my behaviors. Particularly when they highlight something in ways I hadn’t thought about. All the emotive reasoning and rationalizing can sound perfectly correct, but seeing a $ impact usually makes it hit home for me.

Trading too often can be a result of the constant stimulation we are exposed to (only when we travel away from the islands of investing of course ;)). We might realize intuitively that too much trading is harmful for our returns, but usually what comes to mind is someone who trades every day. It seems obvious that spending Rs.1000 a day on brokerage fees, over 250 business days, is a whole lot of money that could have been used to invest instead (Rs.2,50,000!).

However what might not be as obvious is how relatively infrequent trading can take huge chunks out of our portfolio over the longer-term.

Think Compounding

It’s not just the money you spend trading that is gone forever, it’s also what that money could have become or even better, could have compounded into.

The compounding of very small amounts becomes an astoundingly large amount over long periods of time. But is gets even more dramatic the further into the future we look. After 50 years, the difference between 1 trade per year and 1 trade per month can be 500% higher!

The longer the time period you’re considering, the more important these factors become. If you’re a young investor looking to put something away for your future children, or your own retirement in 20 years, this has real implications.

Dangers of short term trading

Think about it – only trading twice per month can have this sort of impact on your portfolio!! And that’s not even considering the tax you might pay when you sell! And you might be trading much more than you realise. I recall a period where I planned on all my share purchases having a 3 to 5 year horizon. After looking back at my transactions over this period, I was shocked to realize my average holding period had only been 2 months!!!*

Apart from the steep brokerage fees, there is also the stress and lost peace of mind. How often do you check your intra day positions? How often do you regret selling or not buying at a certain level?

Thinking Long Term

The problem is most of us have a hard time thinking long term. Over a 3 year period, the impact is not that dramatic. If you keep thinking on a 2 or 3 year horizon, you’ll never notice this.

However when you stop and look back on 15 or 20 years of investing, you might see the
damage all that trading has done, when it’s too late.

This doesn’t just apply to investing. It can be hard to see the benefit of saving that extra Rs.1000 per day not buying a coffee, or doing a little exercise each day, because the real benefits happen long-term. It’s only if you take the time to ‘zoom out’ that you can see the ultimate impact these things have.

How to avoid the dangers of frequent trading

So what insights can we take away from this, to help us become better investors?

Before Buying

Think carefully before you invest in a share – you should have a clear idea of what you expect from your investment, and how long you expect to hold for. This is not to say you should only buy to hold forever (although this could be the ideal approach if you nd the right shares). If your plan is to hold for 6 months, and you expect to make an average 50% return, then by all means stick with it. But you should buy shares only when you’re condent about your decision – this helps avoid indiscriminate buying and selling.

Before Selling

If you are considering selling a share, think carefully about why rst – Are you getting impatient? Are you overreacting to some negative news? Do you think you’ve found something better? Or do you just have the urge to splash out on a new at screen TV and don’t have the cash handy? Ideally, you should know what will cause you to sell before you have bought, to avoid acting on short term whims and handing over unnecessary fees to your broker.

Stock Alerts and Tips

Are your ‘subscriptions’ worth it? How about those so called pundits you follow on Twitter and Telegram?

Think about the impact of annual subscriptions to those ‘hot tips’ style newsletters or other investment related expenses. Are the benefits above and beyond the returns you’d get from just investing that money and letting it grow? Plus the peace of mind in not running after what ever they call hot, only to realize you are late and it never was the right call.

Index Investing

Consider index investing (for the long-term) – There are obviously some ongoing fees involved with this also (and you should look at the long term implications of these by doing your own calculations), as well as other tradeoffs. But if you don’t think you can avoid indiscriminate buying and selling, due to impatience or indecision, perhaps this is an alternative for you. Be aware however that you can still buy and sell into many indices fairly freely, so it may not solve your trading issue completely.

Goals First

Have a clear plan in general before you invest! – I get very frustrated by realising a month after I bought something that I had been impatient, and hadn’t followed my plan. This can potentially end up costing you more than just the trading costs to rectify.

Conclusion

Warren Buffet has talked about imagining you have a ticket with only 20 punch-holes for the rest of your life, and every time you make an investment, one hole is punched. How would this change the way you look at your investments? I think Buffet’s point was more focused on buying the best quality businesses that you expect to be around forever, but it also supports the benefits of minimizing your trading.

So I challenge you to review your trading history over the past few months or years, and work out what impact this might have had on your long term results. Even if you think you trade very rarely, it can be an eye-opening exercise.

*I’m sure there are some people out there that make great money from frequent trading, making up for the high transaction and tax costs – but I am not one of them. However unless you get a real kick out of it, I think it’s simpler and far better to avoid this world of frequent trading completely – it also makes it hard to relax and enjoy your time on beautiful islands such as these 😉

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